Niagara Mohawk Power Corporation Financial Statements For the years ended March 31, 2013 and March 31, 2012

Transcription

1 Niagara Mohawk Power Corporation Financial Statements For the years ended March 31, 2013 and March 31, 2012

2 NIAGARA MOHAWK POWER CORPORATION TABLE OF CONTENTS Page No. Independent Auditor's Report 2 Balance Sheets 3 March 31, 2013 and March 31, 2012 Statements of Income 5 Years Ended March 31, 2013 and March 31, 2012 Statements of Comprehensive Income 6 Years Ended March 31, 2013 and March 31, 2012 Statements of Cash Flows 7 Years Ended March 31, 2013 and March 31, 2012 Statements of Capitalization 8 March 31, 2013 and March 31, 2012 Statements of Changes in Shareholders' Equity 9 Years Ended March 31, 2013 and March 31, 2012 Notes to the Financial Statements 10 1

3 Independent Auditor's Report To the Shareholder and Board of Directors of Niagara Mohawk Power Corporation: We have audited the accompanying financial statements of Niagara Mohawk Power Corporation, which comprise the balance sheets as of March 31, 2013 and March 31, 2012, and the related statements of income, comprehensive income, cash flows, capitalization and changes in shareholders equity for the years then ended. Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on the financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Company's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Niagara Mohawk Power Corporation at March 31, 2013 and March 31, 2012, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. September 20, 2013 PricewaterhouseCoopers LLP, 300 Madison Avenue, New York, NY T: (646) , F: (646) ,

4 NIAGARA MOHAWK POWER CORPORATION BALANCE SHEETS ASSETS March 31, Current assets: Cash and cash equivalents $ 14,672 $ 2,213 Restricted cash 34,982 18,380 Special deposits 15,671 16,484 Accounts receivable 572, ,215 Allowance for doubtful accounts (126,209) (189,593) Accounts receivable from affiliates 7,327 2,489 Intercompany money pool 97, ,250 Unbilled revenues 149, ,402 Materials, supplies and gas in storage 43,178 59,078 Derivative contracts 19,497 1,364 Regulatory assets 56, ,220 Current portion of deferred income tax assets 119, ,301 Prepaid taxes 66,074 53,961 Prepaid and other current assets 58,483 60,632 Total current assets 1,129,960 1,159,396 Equity investments 3,933 5,245 Property, plant, and equipment, net 7,080,116 6,760,766 Deferred charges and other assets: Regulatory assets 1,079,734 1,150,894 Goodwill 1,289,132 1,289,132 Derivative contracts 6, Financial investments 28,177 29,099 Other deferred charges 34,626 14,688 Total deferred charges and other assets 2,437,871 2,484,163 Total assets $ 10,651,880 $ 10,409,570 The accompanying notes are an integral part of these financial statements. 3

5 NIAGARA MOHAWK POWER CORPORATION BALANCE SHEETS LIABILITIES AND CAPITALIZATIO N March 31, Current liabilities: Accounts payable $ 183,196 $ 186,720 Accounts payable to affiliates 134,687 32,707 Current portion of long-term debt 45, ,000 Taxes accrued 26,818 39,848 Customer deposits 34,669 38,476 Interest accrued 27,716 30,938 Payroll and benefits accruals 53,937 46,106 Regulatory liabilities 178,126 84,580 Advance from affiliates 20,000 19,654 Derivative contracts ,581 Other current liabilities 25,056 37,442 Total current liabilities 730,297 1,060,052 Deferred credits and other liabilities: Regulatory liabilities 737, ,091 Asset retirement obligations 10,329 9,937 Deferred income tax liabilities 1,691,829 1,563,702 Postretirement benefits 244, ,535 Environmental remediation costs 438, ,130 Derivative contracts 472 2,672 Other deferred liabilities 337, ,989 Total deferred credits and other liabilities 3,460,792 3,515,056 Capitalization: Shareholders' equity 3,906,475 3,934,735 Long-term debt 2,554,316 1,899,727 Total capitalization 6,460,791 5,834,462 Total liabilities and capitalization $ 10,651,880 $ 10,409,570 The accompanying notes are an integral part of these financial statements. 4

6 NIAGARA MOHAWK POWER CORPORATION STATEMENTS OF INCOME Years Ended March 31, O perating revenues: Electric services $ 2,775,045 $ 2,916,767 Gas distribution 587, ,623 Total operating revenues 3,362,700 3,571,390 O perating expenses: Purchased electricity 880, ,992 Purchased gas 247, ,264 Operations and maintenance 1,217,606 1,203,771 Depreciation and amortization 214, ,468 Amortization of stranded costs and rate plan deferrals 197, ,160 Other taxes 244, ,531 Total operating expenses 3,001,812 3,231,186 O perating income 360, ,204 O ther income and (deductions): Interest on long-term debt (76,407) (66,804) Other interest, including affiliate interest (18,273) (38,355) Other income (deductions), net 5,986 (4,366) Total other deductions, net (88,694) (109,525) Income before income taxes 272, ,679 Income taxes: Current (2,259) 77,832 Deferred 98,293 24,768 Income tax expense 96, ,600 Net income $ 176,160 $ 128,079 The accompanying notes are an integral part of these financial statements. 5

7 NIAGARA MOHAWK POWER CORPORATION STATEMENTS OF COMPREHENSIVE INCOME Years Ended March 31, Net income $ 176,160 $ 128,079 Other comprehensive income (loss): Unrealized gains on securities, net of $1,151 and $729 tax expense 1,727 1,093 Changes in pension and other postretirement obligations, net of $449 and $155 tax benefit (674) (233) Reclassification of losses into net income, net of $362 and $416 tax benefit (544) (624) Other comprehensive income Comprehensive income $ 176,669 $ 128,315 The accompanying notes are an integral part of these financial statements. 6

8 NIAGARA MOHAWK POWER CORPORATION STATEMENTS OF CASH FLOWS Years Ended March 31, O perating activities: Net income $ 176,160 $ 128,079 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 214, ,468 Amortization of stranded costs and rate plan deferrals 197, ,160 Provision for deferred income taxes 98,293 24,768 Amortization of debt discount and issuance costs 3,739 2,497 Bad debt expense (18,241) 36,996 Loss from equity investments Allowance for funds used during construction (7,138) (6,356) Pension and other postretirement expense 150, ,321 Pension and other postretirement contributions (201,191) (285,655) Net environmental remediation payments (31,438) (11,923) Changes in operating assets and liabilities: Accounts receivable, net and unbilled revenues (120,104) 138,976 Materials, supplies and gas in storage 15,900 (20,187) Accounts payable and accrued expenses 1,085 (20,768) Prepaid and accrued taxes (13,129) (129,647) Accounts receivable from/payable to affiliates, net 27,296 (500) Other liabilities (86,915) (83,441) Derivative contracts (69,274) 120,087 Regulatory assets and liabilities, net 179,293 18,306 Other, net (15,777) 2,601 Net cash provided by operating activities 500, ,920 Investing activities: Capital expenditures (497,962) (464,365) Affiliated money pool borrowing and other 89,925 (97,596) Changes in restricted cash (16,602) (18,380) Cost of removal (49,152) (43,552) Other (5,614) 2,119 Net cash used in investing activities (479,405) (621,774) Financing activities: Dividends paid on common and preferred stock (211,060) (1,060) Payments on long-term debt obligation (500,000) - Proceeds from issuance of long-term debt 700,000 - Changes in advance from affiliates Payment of debt issuance costs (4,200) - Parent tax loss allocation ,552 Share based compensation 5,686 - Affiliated money pool borrowing and other - (165,804) Net cash used in financing activities (8,783) (125,312) Net increase (decrease) in cash and cash equivalents 12,459 (8,166) Cash and cash equivalents, beginning of year 2,213 10,379 Cash and cash equivalents, end of year $ 14,672 $ 2,213 Supplemental disclosures: Interest paid $ (91,047) $ (77,180) Income taxes paid (99,349) (218,390) Significant non-cash item: Capital-related accruals included in accounts payable 11,396 23,410 The accompanying notes are an integral part of these financial statements. 7

9 NIAGARA MOHAWK POWER CORPORATION STATEMENTS OF CAPITALIZATION March 31, Total shareholders' equity $ 3,906,475 $ 3,934,735 Long-term debt: Interest Rate Maturity Date Unsecured notes: Senior Note 3.55% October 1, , ,000 Senior Note 4.88% August 15, , ,000 Senior Note 4.12% November 28, ,000 - Senior Note 2.72% November 28, ,000-1,950,000 1,250,000 State Authority Financing - Tax exempt NYSERDA Taxexempt 5.15% November 1, ,000 75,000 NYSERDA Taxexempt Variable October 1, July 1, , ,065 Total 650, ,065 Intercompany Notes: Niagara Mohawk Holdings Inc. Note 5.80% November 1, ,000 Unamortized debt discounts (149) (338) Total long-term debt 2,599,916 2,399,727 Long-term debt due within one year 45, ,000 Total long-term debt, excluding current portion 2,554,316 1,899,727 Total capitalization $ 6,460,791 $ 5,834,462 The accompanying notes are an integral part of these financial statements. 8

10

11 Note 1. Summary of Significant Accounting Policies A. Nature of Operations NIAGARA MOHAWK POWER CORPORATION NOTES TO THE FINANCIAL STATEMENTS Niagara Mohawk Power Corporation (the Company, we, and our ), a New York Corporation, is engaged principally in the regulated energy delivery business in New York State. The Company provides electric service to approximately 1.6 million customers in the areas of eastern, central, northern, and western New York and sells, distributes, and transports natural gas to approximately 0.6 million customers in the areas of central, northern, and eastern New York. The Company is a wholly-owned subsidiary of Niagara Mohawk Holdings, Inc., which is wholly-owned by National Grid USA ( NGUSA ), a public utility holding company with regulated subsidiaries engaged in the generation of electricity and the transmission, distribution, and sale of both natural gas and electricity. NGUSA is an indirectly-owned subsidiary of National Grid plc, a public limited company incorporated under the laws of England and Wales. The Company has evaluated subsequent events and transactions through September 20, 2013, the date of issuance of these financial statements, and concluded that there were no events or transactions that require adjustment to or disclosure in the financial statements as of and for the year ended March 31, B. Basis of Presentation The financial statements for the years ended March 31, 2013 and March 31, 2012 are prepared in accordance with accounting principles generally accepted in the United States of America ( GAAP ) including the accounting principles for rate-regulated entities. The financial statements reflect the rate-making practices of the applicable regulatory authorities. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Within the statements of cash flows, all amounts that are settled through the Regulated Money Pool (refer to Note 10, Related Party Transactions ) are treated as constructive cash receipts and payments, and therefore are presented as such. C. Regulatory Accounting The Federal Energy Regulatory Commission ( FERC ) and the New York Public Service Commission ( NYPSC ) provide the final determination of the rates the Company charges its customers. In certain cases, the rate actions of the NYPSC can result in accounting that differs from non-regulated companies. In these cases, the Company defers costs (as regulatory assets) or recognizes obligations (as regulatory liabilities) if it is probable that such amounts will be recovered or refunded through the rate-making process, which would result in a corresponding increase or decrease in future rates. D. Revenue Recognition The Company bills its customers on a monthly cycle basis at approved tariffs based on energy delivered, a minimum customer service charge, and, in some instances, their demand. Revenues are determined based on these bills plus an estimate for unbilled energy delivered between the cycle meter read date and the end of the accounting period. These amounts are billed to customers in the next billing cycle following the month-end. As approved by the NYPSC, the Company is allowed to pass through commodity-related costs to customers. Additionally, a transmission revenue adjustment mechanism is in place that reconciles actual and forecast wholesale transmission revenue for pass back to, or recovery from, retail customers. Furthermore, the Company has a revenue decoupling mechanism which allows for annual adjustments to the Company s delivery rates as a result of the reconciliation between allowed revenue and billed revenue. Any difference between the allowed revenue and the billed revenue is recorded as a regulatory asset or liability. The gas distribution business is influenced by seasonal weather conditions. Therefore, the Company s gas utility tariff contains a weather normalization adjustment that provides for recovery from, or refund to, firm customers of material 10

12 shortfalls or excesses of firm delivery revenues (revenues less applicable gas costs and revenue taxes) during a heating season, due to variation from normal weather. The relative proportions of the Company s revenue from the sale and delivery of electricity and gas for the years ended March 31, 2013 and March 31, 2012 is as follows: Electric Gas March 31, March 31, Residential 68% 68% 82% 82% Commercial and industrial 32% 32% 18% 18% E. Property, Plant and Equipment Property, plant and equipment is stated at original cost. The cost of additions to property, plant and equipment and replacements of retired units of property are capitalized. Costs include direct material, labor, overhead, and allowance for funds used during construction ( AFUDC ). The cost of renewals and betterments that extend the useful life of property, plant and equipment are also capitalized. The cost of repairs, replacements, and major maintenance projects, which do not extend the useful life or increase the expected output of the asset, are expensed as incurred. Depreciation is generally computed over the estimated useful life of the assets using the composite straight-line method. Depreciation studies are conducted periodically to update the composite rates and are approved by the NYPSC. Whenever property, plant and equipment is retired, the original cost, less salvage, is charged to accumulated depreciation, and the related cost of removal is removed from the associated regulatory liability. The average composite rates and average service lives for the years ended March 31, 2013 and March 31, 2012 are as follows: Electric Gas Common March 31, March 31, March 31, Composite rates - depreciation 1.8% 1.8% 2.0% 2.0% 1.9% 1.9% Composite rates - cost of removal 0.3% 0.3% 0.5% 0.5% 0.1% 0.1% Total composite rates 2.1% 2.1% 2.5% 2.5% 2.0% 2.0% Average service life 58 years 58 years 49 years 49 years 53 years 53 years The Company s depreciation expense includes estimated costs to remove property, plant and equipment, which is recovered through the rates charged to our customers. At March 31, 2013 and March 31, 2012, the Company had cumulative costs recovered in excess of costs incurred totaling $390.9 million and $401.5 million, respectively. These amounts are reflected as regulatory liabilities in the accompanying balance sheets. In accordance with applicable regulatory accounting guidance, the Company records AFUDC, which represents the estimated debt and equity costs of capital funds necessary to finance the construction of new regulated facilities. The equity component of AFUDC is a non-cash amount within the statements of income. AFUDC is capitalized as a component of the cost of property, plant and equipment, with an offsetting credit to other income (deductions) net for the equity component and other interest expense for the debt component in the accompanying statements of income. After construction is completed, the Company is permitted to recover these costs through inclusion in its rate base and corresponding depreciation expense. 11

13 The components of AFUDC capitalized and composite AFUDC rates for the years ended March 31, 2013 and March 31, 2012 are as follows: F. Goodwill March 31, Debt $ 3,774 $ 2,447 Equity 7,138 6,356 $ 10,912 $ 8,803 Composite AFUDC rate 6.1% 6.1% Goodwill represents the excess of the purchase price of a business over the fair value of the tangible and intangible assets acquired, net of the fair value of liabilities assumed and the fair value of any non-controlling interest in the acquisition. The Company tests goodwill for impairment annually on January 31, and whenever events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. The goodwill impairment analysis is comprised of two steps. In the first step, the estimated fair value of the reporting unit is compared with its carrying value. If the fair value exceeds the carrying value, goodwill is not impaired and no further analysis is required. If the carrying value exceeds the fair value, then a second step is performed to determine the implied fair value of goodwill. If the carrying value of goodwill exceeds its implied fair value, then an impairment charge equal to the difference is recorded. The Company calculated the fair value of the reporting unit in the performance of its annual goodwill impairment test for the fiscal year ended March 31, 2013 utilizing both income and market approaches. To estimate fair value utilizing the income approach, the Company used a discounted cash flow methodology incorporating its most recent business plan forecasts together with a projected terminal year calculation. Key assumptions used in the income approach were: (a) expected cash flows for the period from April 1, 2013 to March 31, 2018; (b) a discount rate of 5.5%, which was based on the Company s best estimate of its after-tax weighted-average cost of capital; and (c) a terminal growth rate of 2.25%, based on the Company s expected longterm average growth rate in line with estimated long-term US economic inflation. To estimate fair value utilizing the market approach, the Company followed a market comparable methodology. Specifically, the Company applied a valuation multiple of earnings before interest, taxes, depreciation and amortization ( EBITDA ), derived from data of publicly-traded benchmark companies, to business operating data. Benchmark companies were selected based on comparability of the underlying business and economics. Key assumptions used in the market approach included the selection of appropriate benchmark companies and the selection of an EBITDA multiple of 10.0, which we believe is appropriate based on comparison of our business with the benchmark companies. The Company ultimately determined the fair value of the business using 50% weighting for each valuation methodology, as we believe that each methodology provides equally valuable information. The resulting fair value of the annual analyses determined that no adjustment of the goodwill carrying value was required at March 31, 2013 or March 31, G. Available-For-Sale Securities The Company holds available-for-sale securities which primarily include equities, municipal bonds and corporate bonds. These investments are recorded at fair value and are included in financial investments in the accompanying balance sheets. H. Cash and Cash Equivalents The Company classifies short-term investments that are highly liquid and have original maturities of three months or less as cash equivalents. Cash and cash equivalents are carried at cost which approximates fair value. 12

14 I. Restricted Cash and Special Deposits Restricted cash primarily consists of New York Independent System Operator ( NYISO ) deposits. Special deposits primarily consist of health care claims deposits. J. Allowance for Doubtful Accounts The Company recognizes an allowance for doubtful accounts to record accounts receivable at estimated net realizable value. The allowance is calculated by applying a reserve factor to outstanding receivables. The reserve factor is based upon historical write-off experience and assessment of customer collectability. K. Materials, Supplies and Gas in Storage Materials and supplies are stated at the lower of weighted average cost or market and are expensed or capitalized into specific capital additions as used. At March 31, 2013 and March 31, 2012, the balance of materials and supplies was $36.1 million and $33.6 million, respectively. The Company s policy is to write-off obsolete inventory. There were no material write-offs of obsolete inventory for the years ended March 31, 2013 or March 31, Gas in storage is stated at weighted average cost, and is expensed when delivered to customers. Existing rate orders allow the Company to pass through the cost of gas purchased directly to customers along with any applicable authorized delivery surcharge adjustments. Accordingly, the value of gas in storage does not fall below the cost to the Company. Gas costs passed through to customers are subject to periodic regulatory approvals and are reported periodically to the NYPSC. At March 31, 2013 and March 31, 2012, gas in storage was $7 million and $25.5 million, respectively. L. Income and Other Taxes Federal and state income taxes have been computed utilizing the asset and liability approach that requires the recognition of deferred tax assets and liabilities for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. National Grid North America Inc. ( NGNA ), (formerly National Grid Holdings Inc.), an indirectlyowned subsidiary of National Grid plc and the intermediate holding company of NGUSA, files consolidated federal tax returns including all of the activities of its subsidiaries. Each subsidiary company is included in the consolidated group and determines its current and deferred taxes based on the separate return method. The Company settles its current tax liability or benefit each year with NGNA pursuant to a tax sharing arrangement between NGNA and its included subsidiaries. Benefits allocated by NGNA are treated as capital contributions. Deferred income taxes reflect the tax effect of net operating losses, capital losses and general business credit carryforwards and the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial statement and income tax purposes, as determined under enacted tax laws and rates. The financial effect of changes in tax laws or rates is accounted for in the period of enactment. Deferred investment tax credits are amortized over the useful life of the underlying property. Additionally, the Company follows the current accounting guidance relating to uncertainty in income taxes which applies to all income tax positions reflected in the accompanying balance sheets that have been included in previous tax returns or are expected to be included in future tax returns. The accounting guidance for uncertainty in income taxes provides that the financial effects of a tax position shall initially be recognized in the financial statements when it is more likely than not, based on the technical merits, that the position will be sustained upon examination, assuming the position will be audited and the taxing authority has full knowledge of all relevant information. The state of New York imposes on corporations a franchise tax that is computed as the higher of a tax based on income or a tax based on capital. To the extent the Company s state tax based on capital is in excess of state tax based on income, the Company reports such excess in other taxes and taxes accrued in the accompanying financial statements. The Company collects certain taxes from customers such as sales taxes, along with other taxes, surcharges, and fees that are levied by state or local governments on the sale or distribution of gas. The Company accounts for taxes that are imposed on customers (such as sales taxes) on a net basis (excluded from revenues). Where these taxes, such as gross receipts taxes, excise tax or other surcharges or fees are imposed on the Company, it accounts for these taxes on a gross basis. Other taxes in the accompanying statements of income primarily include excise tax, property tax and payroll tax. Gas distribution revenues include the collection of excise taxes, while other taxes include the related expense. Excise taxes 13

15 collected and paid for the years ended March 31, 2013 and March 31, 2012 were $39.1 million and $44.9 million, respectively. M. Employee Benefits The Company follows the accounting guidance for defined benefit pension and postretirement benefit ( PBOP ) plans for recording pension expenses and resulting plan asset and liability balances. The guidance requires employers to fully recognize all pension and postretirement plans funded status on the balance sheets as a net liability or asset and requires an offsetting adjustment to accumulated other comprehensive income in shareholders equity. In the case of regulated entities, this offsetting entry is recorded as a regulatory asset or liability when the balance will be recovered from or refunded to customers in future rates. The Company has determined that such amounts will be included in future rates and follows the regulatory format for recording the balances. The Company measures and records its pension and PBOP assets at the yearend date. Pension and PBOP assets are measured at fair value, using the year-end market value of those assets. N. Derivatives Derivatives are financial instruments that derive their value from the price of an underlying item such as interest rates, foreign exchange, credit spreads, commodities, equity or other indices. Derivatives enable their users to manage their exposure to these markets or credit risks. The Company uses derivative instruments to manage our operational market risks from commodities and economically hedge a portion of the Company s exposure to commodity price risk. When economic hedge positions are in effect, the Company is exposed to credit risks in the event of non-performance by counterparties to derivative contracts (hedging transactions), as well as non-performance by the counterparties of the underlying transactions. Commodity Derivative Instruments Regulated Accounting The Company utilizes derivative financial instruments to reduce the cash flow variability associated with the purchase price for a portion of future natural gas and electricity purchases. The Company s strategy is to minimize fluctuations in firm gas and electricity sales costs to the Company s customers. The accounting for these derivatives is recorded as current or deferred assets or liabilities, with offsetting positions recorded as regulatory assets and regulatory liabilities in the accompanying balance sheets. Gains or losses on the settlement of these contracts are initially deferred and then refunded to or collected from the Company s customers consistent with regulatory requirements. Certain non-trading contracts for the physical purchase of electricity qualify for the normal purchase normal sale exception and are accounted for upon settlement. If the Company were to determine that a contract which it elected the normal purchase normal sale exception no longer qualifies, the Company would recognize the fair value of the contract in accordance with the regulatory accounting described above. Balance Sheet Offsetting Accounting guidance related to derivatives permits the offsetting of fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from the derivative instruments recognized at fair value executed with the same counterparty under a master netting arrangement. The Company s accounting practice is to not offset such amounts, and to record and present the fair value of derivative instrument on a gross basis, with related cash collateral recorded as restricted cash in the accompanying balance sheets. O. Fair Value Measurements The Company measures commodity derivatives and available-for-sale securities at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following is the fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value: Level 1 quoted prices (unadjusted) in active markets for identical assets or liabilities that a company has the ability to access as of the reporting date; Level 2 inputs other than quoted prices included within Level 1 that are directly observable for the asset or liability or indirectly observable through corroboration with observable market data; and Level 3 unobservable inputs, such as internally-developed forward curves and pricing models for the asset or liability 14

16 due to little or no market activity for the asset or liability with low correlation to observable market inputs. The asset or liability s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. The Company uses valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. P. Power Purchase Agreements The Company enters into power purchase agreements to serve its electric service customers. The Company evaluates whether such agreements are leases, derivatives, or executory contracts. Power purchase agreements that do not qualify as leases or derivatives are accounted for as executory contracts and are therefore recognized as the electricity is purchased. In making its determination of the accounting for power purchase agreements, the Company considers many factors, including: the source of the electricity, the level of output from any specified facility that the Company is taking under the contract; the involvement, if any, that the Company has in operating the specified facility; the and the pricing mechanisms in the contract among other factors. Q. New and Recent Accounting Guidance Accounting Guidance Adopted in Fiscal Year 2013 Fair Value Measurements In May 2011, the Financial Accounting Standards Board ( FASB ) issued accounting guidance that amended existing fair value measurement guidance. The amendment was issued with a goal of achieving common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards. Consequently, the guidance changes the wording used to describe many of the requirements in GAAP for measuring fair value, requires new disclosures about fair value measurements, and changes specific applications of the fair value measurement guidance. Some of the amendments clarify the FASB s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements including, but not limited to: fair value measurement of a portfolio of financial instruments; fair value measurement of premiums and discounts; and additional disclosures about fair value measurements. This guidance became effective for financial statements issued for annual periods (for non-public entities such as the Company) beginning after December 15, The Company adopted this guidance for the fiscal year ended March 31, 2013, which only impacted its fair value disclosures. There were no changes to our approach to measuring fair value as a result of adopting the new guidance. Goodwill Impairment In September 2011, the FASB issued accounting guidance related to goodwill impairment testing, whereby an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is not required. Otherwise, the entity is required to perform the two-step impairment test. This guidance became effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, The Company adopted this guidance for the fiscal year ended March 31, 2013 and did not elect the option to perform a qualitative analysis. Other Comprehensive Income In June 2011, the FASB issued accounting guidance that eliminated the option to present the components of other comprehensive income as part of the statement of changes in stockholders equity. This new guidance seeks to improve financial statement users ability to understand the causes of an entity s change in financial position and results of operations. As a result of this guidance entities are required to either present the statement of income and statement of comprehensive income in a single continuous statement or in two separate, but consecutive statements of net income and other comprehensive income. This guidance does not change the items that are reported in other comprehensive income or any reclassification of items to net income. In addition, the new guidance does not change an entity s option to present components of other comprehensive income net of or before related tax effects. This guidance became effective for nonpublic companies for fiscal years ending after December 15, 2012, and for interim and annual periods thereafter, and it is to be applied retrospectively. The Company adopted this guidance for the fiscal year ended March 31, 2013, with no impact on its financial position, results of operations, or cash flows. 15

17 Accounting Guidance Not Yet Adopted Offsetting Assets and Liabilities In December 2011, the FASB issued accounting guidance requiring enhanced disclosure related to offsetting assets and liabilities. Under the new guidance, reporting entities will be required to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting agreement, such as for derivatives. In January 2013, the FASB issued additional guidance to clarify that the specific instruments and activities that should be considered in these disclosures, will be limited to recognized derivatives, repurchase and reverse repurchase agreements, and securities lending transactions. This guidance is effective for fiscal years, and interim periods within those years, beginning after January 1, 2013, and is to be applied retrospectively. The Company will begin including the new required disclosures in its fiscal year 2014 quarterly financial statements as applicable and does not expect any impact on its financial position, results of operations, or cash flows. Reclassifications From Accumulated Other Comprehensive Income In February 2013, the FASB issued accounting guidance that requires an entity to report information about significant reclassifications out of accumulated other comprehensive income. The new guidance requires presentation either in a single footnote or parenthetically on the financial statements, of the effect of significant amounts reclassified out of accumulated other comprehensive income based on the corresponding line items in the statement of net income. For amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity would cross-reference other disclosures that provide additional detail about those amounts. The amendments do not change the current requirements for reporting net income or other comprehensive income in the financial statements. For non-public entities, the amendments are effective prospectively for reporting periods beginning after December 15, Early adoption is permitted. The Company is evaluating the impact, if any, on its financial position, results of operations, and cash flows. R. Reclassifications and Out of Period Adjustments The Company identified certain accounting errors from prior years totaling $9.3 million (pre-tax) and $9.4 million (after tax) that were recorded in the current fiscal year, which if had been recorded in the proper period would reduce the current year net income. Such amounts represent 3.4% and 5.4% of fiscal year 2013 pre-tax income and net income, respectively. Management has concluded that such amounts do not materially impact fiscal year 2013 or any of the prior years affected. Certain other reclassifications have been made to the financial statements to conform prior year s data to the current year s presentation. These reclassifications had no effect on the Company s results of operations and cash flows. 16

18 Note 2. Rates and Regulation The following table presents the Company s regulatory assets and regulatory liabilities at March 31, 2013 and March 31, 2012: March 31, Regulatory assets Current: Rate adjustment mechanisms $ 42,347 $ 218,026 Pension and postretirement benefit plans 8,848 - Derivative contracts ,581 Storm costs Merger rate plan stranded costs Losses on reacquired debt 2,716 2,820 Other 1,441 - Total 56, ,220 Non-current: Regulatory deferred tax assets 68,332 54,254 Pension and postretirement benefit plans 479, ,180 Storm costs 27,614 18,153 Rate adjustment mechanisms - Merger rate plan stranded costs Environmental response costs 438, ,130 Derivative contracts 472 2,672 Losses on reacquired debt 17,888 20,604 Other 46,059 28,901 Total 1,079,734 1,150,894 Regulatory liabilities Current: Rate adjustment mechanisms 99,076 83,216 Pension and postretirement benefit plans 22,700 - Derivative contracts 19,497 1,364 Environmental response costs 3,589 - Economic development fund 4,560 - NYPA replacement power and expansion 4,552 - Long-term debt true up 9,077 - Other 15,075 - Total 178,126 84,580 Non-current: Cost of removal 390, ,489 Pension and postretirement benefit plans 152, ,853 Economic development fund 35,786 11,790 Unbilled gas revenue 22,628 22,018 Environmental response costs 23,295 27,641 Derivative contracts 6, Rate adjustment mechanisms ,368 Excess storm reserve 29,778 - Long-term debt true up 9,760 - Federal income tax repair cost deferral 30,113 - Revenue subject to refund 5,300 50,000 Other 30,627 61,582 Total 737, ,091 Net regulatory assets $ 220,650 $ 631,443 17

19 Rate adjustment mechanisms: The Company is subject to a number of rate adjustment mechanisms such as for commodity costs, whereby an asset or liability is recognized resulting from differences between actual revenues and the underlying cost being recovered, or differences between actual revenues and targeted amounts as approved by the NYPSC. Pension and postretirement benefit plans: The amount in regulatory assets primarily represents the Company s deferral related to the underfunded status of its Pension and PBOP plans. The amount in regulatory liabilities primarily represents the excess of amounts received in rates over actual costs of the Company s pension and postretirement benefits plans that are deferred to a regulatory liability to be refunded in future periods and accrued carrying charges as calculated in accordance with the Company s Pension and PBOP reserve mechanism. Storm costs: The Company s rate plan provides for a rate allowance of $29 million for incremental costs associated with major storm events, with variances deferred for future recovery or return to customers, The Company has recorded additional storm cost regulatory assets as of March 31, 2013 arising from costs incurred associated with several smaller storms during the year. Environmental response costs: This regulatory asset represents deferred costs associated with the Company s share of the estimated costs to investigate and perform certain remediation activities at sites with which it may be associated. For the year ended March 31, 2013, the Company increased the estimated reserve by $9.1 million for various sites and incurred expenditures of $31.4 million. The regulatory liability represents the excess of amounts received in rates over the Company s actual site investigation and remediation costs. Under the Company s new rate plan which went into effect April 1, 2013, it has specific rate allowances for these costs at a level of $42.0 million per year ($35.7 million in electric base rates and $6.3 million in gas base rates), with variances deferred for future recovery or return to customers. The Company believes future costs, beyond the expiration of current rate plans, will continue to be recovered through rates. Economic development fund: The Company increased the funding for economic development in base rates, and actual expenditures and economic development discounts above or below the rate allowance are deferred for future recovery. Unbilled gas revenue: Per a stipulation in Case No. 93-G-1062, the Company is permitted to recognize unbilled revenues subject to offsetting the revenues with a regulatory liability to future customers benefit. Cost of removal: The Company s depreciation expense includes estimated costs to remove property, plant and equipment, which is recovered through the rates charged to customers. This regulatory liability represents cumulative costs recovered in excess of costs incurred. For a vast majority of its electric and gas distribution assets, the Company uses these funds to remove the asset so a new one can be installed in its place. Carrying Charges The regulatory items above are not included in the utility rate base at the time the expenses are incurred or the revenue is billed. The Company records carrying charges, on the regulatory balances related to rate adjustment mechanisms and deferred environmental response costs for which cash expenditures have been made and are subject to recovery or for which cash has been collected and is subject to refund. Carrying charges are not recorded on items for which expenditures have not yet been made. The Company anticipates recovering these costs in the rates concurrently with future cash expenditures. If recovery is not concurrent with the cash expenditures, the Company will record the appropriate level of carrying charges. The following table presents the carrying charges that were recognized in the accompanying statements of income during the years ended March 31, 2013 and March 31, 2012: March 31, Other interest, including affiliate interest $ 3,574 $ 6,154 Other income, net (3,425) (3,641) $ 149 $ 2,513 Other interest, including affiliate interest for the year ended March 31, 2012 includes an amount of $3.7 million related to prior period carrying charges dating back to October

20 Rate Matters March 2013Electric and Gas Filing On April 27, 2012, the Company filed with the NYPSC to adjust its base electric and gas rates. The Company s filing sought to increase electric delivery base revenues by approximately $130.7 million and gas delivery base revenues by approximately $39.8 million. In October 2012, the Department of Public Service ( DPS ) Staff, the Company and other parties reached a comprehensive agreement to settle both cases. A joint proposal formalizing the settlement agreement was filed December 7, 2012 and the Company received a final order from the NYPSC in these proceedings in March The term of the new rate plan is from April 1, 2013 through March 31, The joint proposal provides for an increase in the electric revenue requirement of $43.4 million in the first year, an increase of $51.4 million in the second year, and an increase of $28.3 million in the third year. It also provides for a decrease in the gas revenue requirement of $3.3 million in the first year, and increases of $5.9 million and $6.3 million in the second and third years, respectively. Transmission ROE Complaint On September 11, 2012, the New York Association of Public Power filed with the FERC a complaint under Section 206 of the Federal Power Act against Niagara Mohawk Power Corporation, seeking to have the base ROE for transmission service from the FERC approved rate of 11.5% which includes a NYISO participation incentive adder, lowered to 9.49%. Similarly, on November 2, 2012 the Municipal Electric Utilities Association ( MEUA ) filed a Section 206 complaint with the FERC seeking to lower the Company s ROE to 9.25% including the NYISO participation adder. MEUA also challenges certain aspects of the Company s transmission formula rate. At this time, the Company cannot predict the outcome of the complaint. Any change in the ROE would not have an impact on net income because the retail rate plan fully reconciles any increase or decrease in wholesale transmission revenue under the FERC Transmission Service Charge rate through a Transmission Revenue Adjustment Clause mechanism. Wholesale Transmission Service Charge On March 29, 2013, the Company filed with the FERC to amend Niagara Mohawk s Scheduling, System Control and Dispatch Costs formula under the Wholesale Transmission Service Charge to incorporate costs incurred by the Company for Reliability Support Services ( RSS ), which are for the purpose of securing the ongoing reliability of NGUSA s transmission system. On August 30, 2013, the FERC rejected the Company's request without prejudice to make a new filing to provide additional support for recovery of RSS costs. The Company plans to submit the additional filing in fiscal year Other Regulatory Matters The NYPSC s January 2011 Order in Niagara Mohawk s 2010 electric rate case required an audit relating to the Company s service company cost allocations, policies and procedures. In February 2011, the NYPSC selected Overland Consulting Inc. ( Overland ), a management consulting firm, to perform the audit of Niagara Mohawk and KeySpan Gas East Corporation and Brooklyn Union Gas Company. Management has evaluated the need for and amount of a reserve based on consideration of the matters set out in the audit and taking into account all known information about the audit related to transaction testing, normalization adjustments, efficiency adjustments and the impact of our new cost allocation methodologies. As of December 31, 2011, the Company had reserved $50 million based on the identified issues above. Overland issued a final report identifying approximately $5 million of service company overcharges to Niagara Mohawk based on extrapolated test results, which the Company is contesting. On January 18, 2013 the NYPSC issued an Order commencing a new proceeding to determine what, if any, ratemaking adjustments are appropriate. The Company determined that the revenue subject to refund that was previously contingent in the amount of $44.7 million is no longer probable of refund and has been recognized in income. A reserve of $5.3 million has been recorded in Niagara Mohawk s financial statements as of March 31, The Company does not believe that the outcome of this matter will have a material impact on its financial position, results of operations, or cash flows. In February 2013, the NYPSC initiated a comprehensive management and operational audit of NGUSA s New York gas businesses, including the Company, pursuant to the Public Service Law requirement that major electric and gas utilities undergo an audit every five years. On June 13, 2013, the NYPSC selected NorthStar Consulting Group to conduct the audit, which commenced in July At the time of the issuance of these financial statements, the Company cannot predict the outcome of this management and operational audit. 19